The Missing Piece in the Foreclosure Solution

THE MISSING PIECE IN THE FORECLOSURE SOLUTION

Notwithstanding a lot of attention, creativity and money, no one has yet to solve the foreclosure crisis engulfing our country. Amidst signs of improvement in other areas (the stock market, the thawing of the credit markets), we see nothing hopeful on the foreclosure front. Arrearages, defaults and foreclosures are continuing at rapid paces, the result being both human costs (people forced out of their homes) and economic loss (declines in housing values).

The Administration is trying to solve the problem with incentives to lenders and servicers to modify loans. To date, these programs have not made a dent in the problem.

The missing piece is debt relief ... not a reduction in interest rates, not an extension of the loan amortization period, not a temporary abatement in mortgage payments. We need to confront the problem head on and stop nibbling at the edges - we need to discuss principal reduction.

Here is the reality: even assuming that people have jobs (I am very aware of the connection between jobs and foreclosures), when one's home is underwater - meaning more debt than value - the desire to fight the good fight is diminished. Why work your butt off to keep paying on a mortgage, even if your payments are reduced to where you can afford them, when all you are doing is treading water?

Today, about 1 in 4 houses with a mortgage are underwater and many more are close. Since about 2/3 of all homeowners have a mortgage, this means that almost 20% of our housing stock has more debt on it than value. That's 13 or 14 million homes. These residents are now quasi-tenants, paying "rent" to a lender so they can stay in their home with little chance of upside. Obviously that was not the thinking going in when these homes were purchased. Many of these homeowners put in equity and hard work with the hope of cashing in someday. That dream is now gone.

I am not making a value judgment one way or another. All I care about is addressing the foreclosure problem. The bankruptcy "cramdown" proposal would have been a help - allowing bankruptcy courts to reduce principal. What's more if that proposal had become law, it would have motivated creditors to reduce principal in negotiation with borrowers - knowing that a cramdown was possible. But, that idea is gone and perhaps dead.

Still, the discussion of principal reductions should be pursued. Perhaps the U.S. has to step up its incentives and/or subsidies to lenders. Perhaps lenders have to be jawboned a little bit - heck the U.S. taxpayer was there when lenders needed them. Whatever the solution, without the missing piece - principal reduction - the foreclosure problem is not going away quickly.

Jim Randel is the founder of The Skinny On book series - books about financial topics presented in an entertaining and quick read. www.theskinnyon.com.

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Comments

[Mike Cassidy]

interesting post, i wonder which members of congress (if any) are a proponent of this approach...

[Jim Randel - Huffpost Blogger]

hi usna (naval academy?) ... i think your approach is creative and deserves further consideration but you do not indicate the principal pay-off amt of the existing loan... is the new loan = FMV? jim randel

[usna73]

Hi Jim, yes Annapolis. You too? Sorry for the delayed response, but your post did not show as a "reply" so I am just seeing it.

Pay off on existing loan is FMV ( loss to lender) perhaps with some Fed $. Beats the heck out of the billions we have poured into propping up some of the zombie banks by comparison.

[usna73]

I agree with the concept but not the details. Both the homeowner and the lender need to suffer a loss because they both made bad decisions. Here is an equitable workout for the nation:

1) Home is assessed at new FMV. Lender accepts new principal as payoff.

2) Government guarantees new loans made by ordinary citizens and investors ( like me) who SAVED, have capital and want to help save their own communities.

3) Homeowner pays interest rate GNMA rate( PLUS 2pts) to new lender ( me). Homeowner pays FNMA rate and Feds make up the difference. WE ( lender and homeowner) share in the upside over the life of the property. Lender can redeem at predetermined time ( government then assumes loan provided homowner has kept their credit decisons in order) of say 10 years. Lender takes their upside at 10 year FMV. Government loan makes up the difference.

Instead what we have today is Feds giving money to bankers who screwed us all. Subsidizing the homeowner who made bad decision ( some are dead beats) is moral hazard.

Rewarding holders of capital who EARNED it and already paid taxes on it makes more sense.